Method and system relating to options on a debt transaction

ABSTRACT

Various embodiments of the present invention are directed to methods and systems relating to options on a debt transaction (e.g., put and call options may be utilized to create an economic effect similar to a reduction in debt of an issuer in exchange for enhancing the terms of a debt holder&#39;s existing debt investment). More particularly, one embodiment relates to a method implemented by a programmed computer system for use in a financial transaction involving a debt issuer and a debt holder, comprising: entering into a put/call contract between the debt issuer and the debt holder, wherein the debt issuer sells the put and buys the call and the debt holder buys the put and sells the call; inputting data associated with the put/call contract regarding conditions under which the debt issuer may retire outstanding debt of the debt issuer; inputting data associated with the put/call contract regarding conditions under which the debt holder may retire outstanding debt of the debt issuer; and retiring at least some of the outstanding debt, wherein the outstanding debt is retired utilizing calculations based upon the input data regarding conditions associated with the put/call contract under which the debt issuer and the debt holder may retire outstanding debt.

RELATED APPLICATIONS

This application is a continuation of and claims priority to U.S. patentapplication Ser. No. 11/113,456 filed on Apr. 25, 2005 and entitled“Method And System Relating To Options On A Debt Transaction,” whichclaims the benefit of U.S. Provisional Application Ser. No. 60/565,209,filed Apr. 23, 2004. The entire content of each application is herebyincorporated by reference.

FIELD OF THE INVENTION

Various embodiments of the present invention are directed to methods andsystems relating to options on a debt transaction (e.g., put and calloptions may be utilized to create an economic effect similar to areduction in debt of an issuer in exchange for enhancing the terms of adebt holder's existing debt investment).

More particularly, one embodiment relates to a method implemented by aprogrammed computer system for use in a financial transaction involvinga debt issuer and a debt holder, comprising: entering into a put/callcontract between the debt issuer and the debt holder, wherein the debtissuer sells the put and buys the call and the debt holder buys the putand sells the call; inputting data associated with the put/call contractregarding conditions under which the debt issuer may retire outstandingdebt of the debt issuer; inputting data associated with the put/callcontract regarding conditions under which the debt holder may retireoutstanding debt of the debt issuer; and retiring at least some of theoutstanding debt, wherein the outstanding debt is retired utilizingcalculations based upon the input data regarding conditions associatedwith the put/call contract under which the debt issuer and the debtholder may retire outstanding debt.

BACKGROUND OF THE INVENTION

From the perspective of an issuer, deterioration in the issuer's creditprofile may shift the issuer's sources of debt funding (e.g., frominvestment grade to non-investment grade markets). Moreover, outstandingdebt may be traded at reduced market values due to a mismatch in termsrelative to the current credit profile (e.g., coupon, covenants,maturity).

In this regard, there may be opportunity for significant improvement inthe credit profile if the issuer can capture some of the economicbenefit of the reduced market value of its debt (one embodiment of thepresent invention provides a synthetic mechanism for capturing theeconomic benefit—such a synthetic mechanism may have significantadvantages due, for example, to reduced friction and tax costs).

From the perspective of a holder of the issuer's debt, a dislocation ininvestor base (e.g., from investment grade to non-investment grade) maycontribute to reduced trading value and liquidity. Moreover, mismatchesin maturity, covenants and coupons relative to the issuer's creditprofile may represent impediments to determining fair value foroutstanding debt.

In this regard, there may be opportunity for improvement in near-termtrading value by “splitting-the-difference” relative to par with issuerand obtaining appropriate maturity, covenants and coupons debt (oneembodiment of the present invention provides a mechanism for such“splitting-the-difference”).

BRIEF DESCRIPTION OF THE DRAWINGS

FIGS. 1A-1D show a financing structure/transaction according to anembodiment of the present invention.

Among those benefits and improvements that have been disclosed, otherobjects and advantages of this invention will become apparent from thefollowing description taken in conjunction with the accompanyingfigures. The figures constitute a part of this specification and includeillustrative embodiments of the present invention and illustrate variousobjects and features thereof.

DETAILED DESCRIPTION OF THE INVENTION

Detailed embodiments of the present invention are disclosed herein;however, it is to be understood that the disclosed embodiments aremerely illustrative of the invention that may be embodied in variousforms. In addition, each of the examples given in connection with thevarious embodiments of the invention are intended to be illustrative,and not restrictive. Further, the figures are not necessarily to scale,some features may be exaggerated to show details of particularcomponents. Therefore, specific structural and functional detailsdisclosed herein are not to be interpreted as limiting, but merely as arepresentative basis for teaching one skilled in the art to variouslyemploy the present invention.

Referring now to an overview of one embodiment of the present invention,it is noted that an options on debt transaction according to thisembodiment may utilize an essentially simultaneous issuance of put andcall options that are bundled into a separable unit with a certain classor series of an issuer's outstanding debt (which outstanding debt maychange from time to time). More particularly, under this embodiment:

-   -   The put/call contract between the issuer (issuer sells put, buys        call) and the holder or holders (holder buys put, sells call)        may have shorter maturities than some or all of the issuer's        existing debt.    -   European-style put and call options may give the holder and        issuer the right to retire outstanding debt at a specific price        in the future that represents a premium relative to current        trading levels but is less than par.    -   The put/call contract may also include fixed maintenance        payments (from the issuer to the holder, or vice versa) and/or        non-investment grade incurrence covenants (e.g., related to        acceleration of the put) that are appropriate for the issuer's        current credit profile.    -   Holders may pledge their outstanding debt as a withdrawable        collateral component of the unit (e.g., backing their        obligations under the call option).    -   Holders may also agree as part of put/call contract to reduce        the repayment claim associated with their pledged debt in the        event of an acceleration or bankruptcy.    -   It is believed that the issuer should have no current        recognition of cancellation of indebtedness income for tax        purposes since existing debt remains unmodified, outstanding and        separable from the put/call contract

Still referring to the present options on debt transaction embodiment,it is noted that transaction objectives may include, but not be limitedto, the following:

-   -   Economically and contractually reduce issuer's aggregate debt        burden.    -   No current COD tax payable since no specific debt class has been        modified.    -   Enable holders to substitute alternative collateral, e.g., other        classes of issuer debt and/or Treasury bills (arbitrage-based        trading may be inhibited by more restricted liquidity of        “substitute” or “stripped” units).

Referring now to specific illustrative examples of various componentsand terms associated with the present options on debt transactionembodiment (which examples are intended to be illustrative and notrestrictive), it is noted that:

-   -   The put/call contract may allow participating holders to put        $1000 face amount of certain classes or series of issuer debt        (or “Specified Debt”) to issuer in year 12 for $800, as compared        to a current trading value of $750. Terms of put/call contract        may also allow issuer to call $1000 face amount of Specified        Debt from participating Holders in year 15 for $800.    -   Participating holders must pledge $1000 face amount of Specified        Debt or $200 Treasury bills as collateral to secure their        obligations under the call portion of the embedded contract.    -   Holders make fixed annual maintenance payments of $3.50 (or 35        bp of face amount of Specified Debt) prior to expiration of the        put option—paid by redirecting the appropriate portion of        interest income on pledged Specified Debt.    -   Pledged Specified Debt or Treasury bills may be contributed to        an escrow account and held by a collateral agent.        -   Holders may elect, from time to time, to substitute            alternative classes of issuer's debt that meets certain            prescribed specifications necessary to be considered            “Eligible Debt”, such as maturity (e.g., at least as long as            Specified Debt) and seniority (e.g., pari passu with            Specified Debt).        -   Holders may also elect to substitute Treasury bills to            support their potential obligation under the call option.    -   Holders continue to receive coupon income from Eligible Debt or        Treasures that are held by collateral agent, reduced by any        maintenance payments owed to issuer depending on actual class of        debt substituted.    -   Bankruptcy acceleration of put/call contract effectively results        in holder forfeiting $200 of principal claim relating to any        debt held by collateral agent on behalf of holder (or forfeiture        $200 of Treasures contributed by holder to collateral agent as a        net settlement).

Of note, various substitution alternatives associated with theabove-described example may include (but not be limited to) following:

-   -   Reclaim $1000 face amount of initially pledged Specified Debt        and replace with $1000 face amount of other Eligible Debt,        creating a “substitute unit”    -   Reclaim $1000 face amount of initially pledged Specified Debt        and pledge short-term Treasuries with $200 principal amount        (maximum net-value investors would have to deliver to issuer        upon call exercise), creating a “stripped unit.

Referring now to FIGS. 1A-1CD, funds flow and settlement alternatives ofan embodiment of the invention will be described (FIG. 1A refers tocomponents of a unit; FIG. 1B refers to interim funds flow; FIG. 1Crefers to substitution rights and FIG. 1D refers to settlement of aunit).

More particularly, as seen in FIG. 1A, issuer enters into put/callcontract with holders who transfer Specified Debt or Treasury bills tocollateral agent to support obligations under the embedded call in thecontract. Further, the put/call contract may include covenantsappropriate for non-investment grade issuers. Further still, the holderscontractually reduce claim in the event of acceleration.

Moreover, as seen in FIG. 1B, prior to exercise of put or call, holdersreceive interest payments on any pledged Specified Debt as well as fixedmaintenance payments on the unit, if appropriate. Further, the terms ofSpecified Debt relative to offered yield on unit determine whether aportion of coupon is paid back to issuer.

Moreover, as seen in FIG. 1C, holders have the right to substitutecollateral in respect of the call obligation (e.g., different classes ofissuer's Eligible Debt or Treasuries with a principal amount equal to20% of par amount Eligible Debt requirement).

Moreover, as seen in FIG. 1D, on put exercise, investors tender 100% ofEligible Debt $1000 face amount in exchange for $800 (it is believedthat this would trigger taxable cancellation of debt income to issuer).Further, on call exercise, issuer pays $800 per $1000 face amountEligible Debt or receives net settlement of $200 in Treasuries.

Reference will now be made to an illustrative example credit impactanalysis (benefits and issues to consider) related to an embodiment ofthe present invention (of course, this example is intended to beillustrative and not restrictive).

More particularly, it is noted with regard to benefits that:

-   -   There may be meaningful economic debt reduction for issuer.        -   Upon exercise of either put or call.        -   Contractual reduction of holders' claims in the event of            bankruptcy or acceleration.    -   May also result in improvement in issuer's interest coverage if        holders have to make contract maintenance payments out of coupon        income.    -   Enhanced investment opportunity for holders.        -   Improved liquidity via unit structure.        -   Re-aligned covenants and maturity profile that are            appropriate for issuer's current credit profile.        -   Maintenance payments on put/call contract help ensure holder            obtains fair value for contract.    -   Should not result in any current tax cost to issuer

Further, it is noted with regard to issues to consider that:

-   -   There may be economic reduction in issuer's maturity profile if        put or call are exercised.        -   However, term may still be long-term (e.g., 12-15 years) and            may be structured to match issuer's specific maturity            profile.        -   Earliest possible redemption via put/call contract may be            structured to occur later than recently-issued 7 and 10 year            non-investment grade debt.    -   Potential increase in issuer's cash expenses requirements if        maintenance payments on put/call contract require net payments        to holders.    -   It is believed that GAAP statements will not reflect the debt        reduction, despite economic and contractual impact.

Reference will now be made to an illustrative example of terms andsettlement related to an embodiment of the present invention (of course,this example is intended to be illustrative and not restrictive).

More particularly, it is noted with regard to strike price andexpiration that:

-   -   European-style put and call contract between issuer and holder        grants the following rights:        -   Holder has right to require that issuer purchases $1,000            face amount of Eligible Debt for $800 on last day of Year            12.        -   Issuer has right to require that holder deliver $1,000 face            amount of Eligible Debt for $800 on last day of Year 15.

Further, it is noted with regard to collateral requirement that:

-   -   Upon entering into put/call contract (and at any time that        holder remains a party to the contract), holder must post        collateral via one of the following methods:        -   Deposit $1,000 face amount of issuer's Specified Debt.        -   Deposit $1,000 face amount of issuer's securities that            qualify as Eligible Debt.        -   Deposit $200 of short-term Treasuries.        -   Issuer may have no ability to specify or restrict holders'            ability to withdraw and substitute replacement collateral,            so long as it qualifies under one of the methods described            above.

Further, it is noted with regard to additional contract terms that:

-   -   Issuer agrees to covenants typical of non-investment grade debt        indentures.    -   Issuer and holder agree to make or receive fixed periodic        payments that represent the “value spread” between the put and        call components of the contract.    -   Holder agrees to forfeit $200 of bankruptcy claim relating to        each $1,000 of Specified or Eligible Debt pledged as collateral        (or forfeits entire $200 of Treasuries if substituted as        collateral).

Further, it is noted with regard to net settlement that:

-   -   At the option of the holder, the call obligation may be settled        in cash for $200, enabling holder to retain ownership of the        Eligible Debt (and reclaim any collateral on deposit with        collateral agent).    -   Put obligation may not be net settled.

Reference will now be made to an illustrative example of rational forsubstitution of underlying collateral related to an embodiment of thepresent invention (of course, this example is intended to beillustrative and not restrictive). More particularly, it is noted that:

-   -   Unit holders will likely choose to substitute collateral among        the various classes of Eligible Debt for a variety of reasons.        In particular, since the exchange ratios relating to each class        of Eligible Debt may be set at the pricing date, it is likely        that subsequent changes in the non-unit trading prices of the        various classes will result in one class becoming “cheaper to        deliver” relative to other classes.        -   Variations in duration and convexity across classes of            Eligible Debt—Upon large moves in yields for a given issuer,            the relative non-unit trading prices of the Eligible Debt            classes will change dramatically. The larger the original            difference in duration, the larger the potential divergence            in relative trading prices. For example (which example is            intended to be illustrative and not restrictive), an 8%            25-year bond priced at 75 has a 8.9 duration, and an 8%            30-year bond priced at 75 has a 9.1 duration.            -   If yields fall by 100 bp on each bond the prices of the                25-year and 30-year bonds will be 82.20 and 82.46,                respectively. That is a ratio of 1.003 versus the                original 1.000.            -   If yields rise by 100 bp on each bond the prices of the                25-year and 30-year bonds will be 68.82 and 68.68,                respectively. That is a ratio of 0.998 versus the                original 1.000.        -   Maturation of Eligible Debt—Over the life of the Eligible            Debt, the relative duration and applicable Treasury pricing            benchmarks will change.            -   Over a 12-year horizon (for example), 25-year and                30-year bonds become 13-year and 18-year bonds with                respective durations (assuming constant yields) of 7.3                and 8.3, implying increased sensitivity to shifts in                yield for the issuer and enhanced likelihood that                Eligible Debt trading prices diverge, as described                above.            -   Similarly, the aging of the bonds will require that                different US Treasury securities are utilized as the                applicable underlying pricing benchmark. As of about                April, 2004, the difference in US Treasury rates between                an 8-year and 20-year security was approximately 130 bp,                while the yield difference between an 18-year and                30-year security was only 10 bp. Assuming constant                credit spreads, the yield on 20-year Eligible Debt would                drop by more than 120 bp over the life of the class.                Since the different classes of Eligible Debt mature at                different rates, non-unit trading prices are likely to                diverge even if credit spreads relative to the                applicable US Treasury benchmark securities remain                constant.        -   Evolution of the yield curve—The relative shape of the yield            curve can change dramatically over a 12-year period. As of            about April, 2004, the US Treasury yield curve between 10            years and 30 years was extremely steep, whereas six years            ago it was nearly flat. In addition to the measurable shifts            in relative duration as the various classes of Eligible.            Debt age, changes in the shape of the yield curve could            contribute to further divergence (or convergence) of            non-unit trading prices of Eligible Debt classes.        -   In addition to substitution among various classes of            Eligible Debt, there are several scenarios in which unit            holders would likely substitute Treasury securities as            collateral:            -   Significant rally in trading prices of Eligible Debt—If                it became apparent that the issuer's credit spread and                Eligible Debt yield levels will trade not only above the                exercise price of the put/call options but also above                face value, then investors would likely substitute US                Treasury notes as collateral to reduce the implied loss                in present value when the call option is exercised (i.e.                unit holder elects net settlement option).            -   “Short strategy” in the event of decline in trading                prices of Eligible Debt—If the issuer's credit profile                is deteriorating, unit holders may reclaim pledged                Eligible Debt and substitute US Treasury notes as                collateral, speculating that non-unit trading prices for                Eligible Debt will continue to decline (allowing for                later re-substitution of Eligible Debt purchased at                lower than current price).            -   Reluctance to hold high-default risk investments—In the                event of severe declines in an issuer's credit profile,                unit holders may seek to substitute US Treasury notes as                collateral, enabling the unit holder to liquidate its                position in the underlying Eligible Debt and avoid                holding defaulted securities that might violate its                investment charter or require additional regulatory                capital.

Of note, the invention may, of course, be implemented using anyappropriate computer hardware and/or computer software. In this regard,those of ordinary skill in the art are well versed in the type ofcomputer hardware that may be used (e.g., a mainframe, a mini-computer,a personal computer (“PC”), a network (e.g., an intranet and/or theInternet)), the type of computer programming techniques that may be used(e.g., object oriented programming), and the type of computerprogramming languages that may be used (e.g., C++, Basic). Theaforementioned examples are, of course, illustrative and notrestrictive.

While a number of embodiments of the present invention have beendescribed, it is understood that these embodiments are illustrativeonly, and not restrictive, and that many modifications may becomeapparent to those of ordinary skill in the art. For example, certainmethods have been described herein as being “computer implemented”. Inthis regard, it is noted that while such methods can be implementedusing a computer, the methods do not necessarily have to be implementedusing a computer. Also, to the extent that such methods are implementedusing a computer, not every step must necessarily be implemented using acomputer. Further, the specific dates, time spans, rates, prices, valuesand the like described with reference to the various examples are, ofcourse, illustrative and not restrictive. Further still, the inventionmay encompass a “structure,” a “transaction,” a “system” and/or a“method”. Further still, any actions or steps may be done periodically(wherein the term periodic could refer, for example, to daily, weekly,monthly, quarterly, semiannually, annually or at varying intervals).Further still, the various steps may be carried out in any desiredorder, one or more steps may be deleted and/or one or more steps may beadded.

1. A method implemented by a programmed computer system for use in afinancial transaction involving a debt issuer and a debt holder,comprising: inputting, into the computer system, data associated withentry into a multi-component option contract between the debt issuer andthe debt holder, wherein the debt issuer sells a put on outstanding debtbetween the debt issuer and the debt holder and buys a call on theoutstanding debt, and the debt holder buys the put and sells the call asa counterparty to the multi-component option contract; inputting, intothe computer system, data associated with the multi-component optioncontract regarding conditions for retiring the outstanding debt of thedebt issuer by the debt issuer, and conditions for retiring theoutstanding debt of the debt issuer by the debt holder; and retiringsome of the outstanding debt, wherein the outstanding debt is retiredutilizing a calculation, done by the computer system, based upon theinput data regarding the conditions associated with the multi-componentoption contract; wherein the multi-component option contract is bundledinto a separable unit with some of the outstanding debt, allowingsubstitution of the outstanding debt with other predetermined eligiblecollateral.
 2. The method of claim 1, wherein some of the outstandingdebt is held by the debt holder.
 3. The method of claim 1, wherein thedebt holder pledges at least some of the outstanding debt which is heldby the debt holder and which is bundled into the unit as a collateralcomponent of the unit.
 4. The method of claim 1, wherein the collateralcomponent is pledged as a withdrawable collateral component,substitutable with other predetermined eligible collateral.
 5. Themethod of claim 4, wherein the multi-component option contract comprisesan agreement by the debt holder that a bankruptcy or accelerationreduces a repayment claim associated with the pledged debt.
 6. Themethod of claim 4, wherein the collateral component is pledged as awithdrawable collateral component, substitutable with other eligiblecollateral, to back the obligations of the debt holder under the call.7. The method of claim 6, wherein the debt provides substitutecollateral to replace at least part of the outstanding debt which isheld by the debt holder and which is bundled into the unit.
 8. Themethod of claim 7, wherein the substitute collateral comprises U.S.Treasuries.
 9. The method of claim 1, wherein the multi-component optioncontract gives the debt issuer the right to retire at least some of theoutstanding debt at a predetermined price in the future.
 10. The methodof claim 1, wherein the multi-component option contract gives the debtholder the right to retire at least some of the outstanding debt at apredetermined price in the future.
 11. The method of claim 1, whereinthe multi-component option contract includes at least one maintenance orinterest payment.
 12. The method of claim 11, wherein themulti-component option contract includes a plurality of periodicmaintenance or interest payments.
 13. The method of claim 12, whereinthe plurality of periodic maintenance or interest payments are made fromthe debt issuer to the debt holder.
 14. The method of claim 12, whereinthe plurality of periodic maintenance or interest payments are made fromthe debt holder to the debt issuer.
 15. The method of claim 1, whereinthe multi-component option contract includes at least one incurrencecovenant related to acceleration of the put.
 16. The method of claim 1,wherein the call is net settled.
 17. A programmed computer system foruse in a financial transaction involving a debt issuer and a debtholder, comprising: a memory; a processor disposed in communication withsaid memory, said memory storing processor-executable instructionsissuable by said processor to: input data associated with entry into amulti-component option contract between the debt issuer and the debtholder, wherein the debt issuer sells a put on outstanding debt betweenthe debt issuer and the debt holder and buys a call on the outstandingdebt, and the debt holder buys the put and sells the call as acounterparty to the multi-component option contract; input, into thecomputer system, data associated with the multi-component optioncontract regarding conditions for retiring the outstanding debt of thedebt issuer by the debt issuer and conditions for retiring theoutstanding debt of the debt issuer by the debt holder; and retire someof the outstanding debt, wherein the outstanding debt is retiredutilizing a calculation based upon the input data regarding theconditions associated with the multi-component option contract; whereinthe multi-component option contract is bundled into a separable unitwith some of the outstanding debt, allowing substitution of theoutstanding debt with other predetermined eligible collateral, whereinthe multi-component option contract gives the debt holder and the debtissuer the right to retire at least some of the outstanding debt at thepredetermined price in the future, and wherein the predetermined priceis at a premium relative to a current trading level of the outstandingdebt and the predetermined price is less than a par value of theoutstanding debt.